Australia’s Central Bank Breathes Easier After Inflation Report

Australia’s economy is slowly recovering from the end of a decade-long boom in mining investment.

Bloomberg

A benign reading on first-quarter inflation gives Australia’s central bank more time to ponder its next policy move.

Consumer inflation rose 0.6% on-quarter in the first three months of the year and was up 2.9% from a year earlier, the Australian Bureau of Statistics said Wednesday. Economists had forecast a 3.2% increase from a year earlier — which would have been a two-year high – and a 0.8% sequential rise.

Core inflation rose by just 0.6% in the quarter – down from a shocking 0.9% a quarter earlier — and by 2.7% on-year.

The softer reading reinforces the Reserve Bank of Australia’s narrative that the economy is slowly rounding into shape and that price pressures are controlled enough for the central bank to stay on hold for the foreseeable future.

“Lower inflation in the first quarter would increase the RBA’s confidence that it can keep interest rates on hold for longer,” said Kieran Davies, chief economist at Barclays, Australia. “Our central case is still that the cash rate remains steady until the end of 2014.”

Importantly for a lot of economists, the snapshot of Australia’s economy now makes a lot more sense.

A surprisingly strong inflation reading to end 2013 had caused the RBA to take further interest-rate cuts off the table, and led some to predict the bank’s next move on rates would be higher. But that inflation spike never properly gelled with other data that showed the unemployment rate rising to a decade high and a moribund economy weighed down by a fading mining boom.

It also was never really clear why Australia would buck the global trend of only moderate inflation.

To be sure, the Australian dollar is much lower than a year ago, which adds to import prices. But the soft economy means businesses have to absorb the price pressures rather than pass them on to consumers.

Wednesday’s data triggered heavy selling of the Australian dollar, which fell to US$0.9285 on the data, from around US$0.9380 beforehand.

Not everyone was convinced that Wednesday’s inflation report was a game-changer.

“Although the outcome is broadly in line with the RBA’s near-term projections, we believe that rising tradeable inflation and sticky services inflation will contribute to the RBA’s decision to hike interest rates in Q4 2014,” Oxford Economics said in a research note.

Even Barclays’ Mr. Davies noted some reasons why the RBA may be forced off the fence sooner than it anticipates. While the central bank expects unemployment to climb throughout 2014, Mr. Davies said business survey indicators suggest the labor market may hit an inflection point in the middle of the year.

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